Annuities

Fixed Immediate annuities can provide a steady income for a specified period of time that may even surpass your natural life. How long you choose to take these payments can depend on your present and future income needs, as well as your survivors’ requirements. But there is one more point that you may want to look at when reviewing the various payout options available, and that is the annuity tax implications to you and your beneficiaries.

A portion of the money you would receive each year is a tax-free return of your investment. The balance is taxable, and those amounts can vary among the different payment periods. For instance, suppose that you are a 65-year old male, the IRS gives you a life expectancy of 20 years, and you are offered the following choices for a $250,000 investment:

• A life only payout ceases when you die and will give you approximately $20,000 per year. Of this amount, $12,500 (1/20th of $250,000) would be tax-free and the balance ($7,500) taxable. If you live longer than 20 years, all $20,000 will be taxable.

• A life with 20-year certain pays for 20 years or your lifetime, whichever is longer. You would receive approximately $17,500 each year, $12,500 tax-free and $5,000 taxable. If you die before the 20 years has passed, your beneficiary will collect the remainder of the payments with the same annuity tax treatment as you had.

• A 10-year certain annuity will pay you approximately $28,500 per year for 10 years with $25,000 (1/10th of $250,000) tax-free and $3,500 taxable. If you die before the 10 years has passed, your beneficiary will receive the income for the balance of the term in a like manner.

The above numbers are strictly estimates and for illustrative purposes only. They do not imply any return on a specific investment, and do not include the impact of fees and charges on the growth or the payout. In addition, other payout options are available. However, they do show how your investment decisions could affect your annuity taxes.

For more information on investing with fixed immediate annuities, ask your retirement consultant.

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One popular benefit of a fixed annuity is that you can let the interest in the account compound each year without paying income taxes. This allows your money to possibly grow faster as compared to fully taxable investments that pay similar, before-tax returns. When you start making withdrawals, the percentage of income that is taxable depends on how you structure the distributions. Your beneficiaries, however, may not have that flexibility, and could face a big annuity tax bill on the inheritance.

Assuming your annuity is not held in a tax-qualified account, such as an IRA, your heirs will have to pay income tax on the built-up earnings when you die. Suppose that you put $250,000 into a fixed annuity a number of years ago, and now it is worth $450,000. If you died today, your beneficiaries would receive the $450,000, and would have to pay as much $70,000 in federal income taxes on the accumulated profit (maximum federal income tax rates are currently 35%).

To help your heirs keep the money you earned, you may want to consider purchasing a life insurance policy for the amount of the estimated tax bill. You could pay the premiums yourself, ask your beneficiaries to buy the policy to protect their future interests, or you could annuitize your annuity.

Annuitizing your annuity can give you a steady income that you cannot out-live. Part of the income will be a tax-free return of your original investment. The balance will be taxed as ordinary income. However, the $450,000 will no longer be available to go to your beneficiaries. To replace that money, you could use the regular income that you will receive from the annuity to help pay life insurance premiums on a $450,000 policy. After you die, your loved ones will receive the entire $450,000, free of federal income taxes.
Not everyone can qualify for a life insurance policy. Depending on the payout from the annuity, your health and other factors, the payout from the annuity may not cover the full premium payment on the life insurance. For more information about annuitization or annuities get a copy of Annuity Owner Mistakes.

Annuity taxation can be onerous or painless depending on your planning and getting qualified advice.

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